Axon Enterprise Inc (AXON) 2010 Q4 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the fourth quarter 2010 TASER International, Inc.

earnings conference call.

My name is Regina, and will I be your Operator today.

(Operator Instructions).

I would now like to turn the conference over to your host for today's event, Mr.

Rick Smith, Chief Executive Officer.

You may proceed, sir.

Thank you, and thanks everybody, for joining us this morning.

As is the norm I will turn it over to our CFO, Dan Behrendt, to first read the Safe Harbor Statement and then we will get started.

Thanks, Rick.

Certain statements in this presentation may be deemed to be forward-looking statements as defined by the Private Securities Litigation Reform Act of 1995.

And TASER International intends that such forward-looking statements be subject to the Safe Harbor created thereby.

Such forward-looking statements relate to expected revenue and earnings growth, estimations regarding the size of our target markets, successful penetration of law enforcement market, expansion of product sales to private security, military, consumer self-defense markets; growth expectations for new and existing counts, expansion of production capability, new product introductions, product safety, and our business model.

We caution these statements are qualified by important factors that could cause actual results to differ materially from those reflected by the forward-looking statements herein.

Such factors include but are not limited to market acceptance for products; establishment, expansion of our direct and indirect distribution models and tracking, retaining the endorsements of key opinion leaders in the law enforcement community, the level of product technology and price competition for our products, the degree and rate of growth of our markets which we compete and accompanying demand for our products, potential delays in international and domestic orders, implementation risks of manufacturing our [nation], risks associated with rapid technological change, execution implementation risks of new technology, new product introduction risks, ramping manufacturing production to meet demand, litigation resulting from the alleged product related injuries and death, media publicity concerning product uses and allegations of injuries and death and the negative impact this could have on sales, product quality risks, potential fluctuations in quarterly operating results, competition, negative reports concerning TASER device uses, financial and budgetary constraints of prospects and customers, dependence on sole limited source of suppliers, fluctuations in component pricing, risks of government investigations and regulations, TASER product tests and reports depends on key employees, employ retention risk and other factors detailed in the Company's filings with Securities and Exchange Commission.

With that I'll turn it back over to Rick Smith.

Thanks, Dan.

Okay.

Again, thanks for joining us today everybody to look back at 2010, but more importantly look forward at 2011.

As is no secret, 2010 was a challenging year in general, particularly for our customers in municipal law enforcement.

If you look back at 2009, the stimulus program was in full swing in 2009, and we had a record year that year.

When it became clear the stimulus spend was not going to continue, really what happened was some necessary restructuring in the cost structure of many government, particularly municipal agencies that were forestalled from 2009, there were crop up operations from stimulus spending.

2010 was the year that the music stopped and everybody had to find a chair.

Then we did a particularly tough year to be selling capital equipment in to -- frankly paramilitary agencies that have a very tight bond of brotherhood, and when those agencies are looking at going through staffing cuts, they will go to extraordinary lengths to try to preserve the jobs of their men and women in arms, and in those environments trying to sell new equipment and new capabilities is exceedingly difficult, and frankly we don't dispute the priorities of our customers.

We're very close with that community.

I would say 2011 is a bright new day in our opinion.

Our distribution network is giving us very positive signs.

Our discussions with law enforcement, it seems that many agencies have been through the restructuring or at least they're in the midst of it now, and that by the midpoint of the year we believe that we're seeing a fundamental shift where agencies will be coming out of this staff-cutting mode, and as they do, they will be facing up to equipment shortfall, shortages in cartridges, outdated equipment that passed its useful life.

There will be pent-up demand, and we believe as we come out the back end of this, our customers as well, knowing how painful it is to go through staffing cuts, are going to be more likely to focus on investing in efficiency systems and improving the efficiency of their work force rather than just staffing right back up immediately, and our core systems, both TASER devices and a new [AXON in EVIDENCE.COM] made dramatic improvements in agency performance on a cost-saving return, on an invested basis, so we believe that positions us very well for the coming market conditions.

In 2010 some specific highlights.

One thing to point out.

At the end of the year, we saw our first major order for the TASER X3s for over 1,000 units by the Arizona State Department of -- I'm sorry the Arizona Highway Patrol, Department of Public Safety.

We saw they were finally able to free up some budget dollars to making the investment in upgrading their equipment.

Over the course of the year we actually were able to start to begin the drive of some upgrades.

A trend that we believe we will be able to continue and will be a major strategic focus in 2011.

We also saw the launch of EVIDENCE.COM and AXON after a multiyear investment cycle not only in the US, but also in New Zealand, that adopted our TASER CAMs and EVIDENCE.COM on a nation wide basis.

I'll talk more when we come back after the break looking at 2010 to talk more about status and program floor with those exciting products.

Detective and Department of Public Safety went full deployment after a multiyear sales engagement and test evaluation program with around 2,700 X26s, one of our larger deployments this year.

We also successfully defended our intellectual property with a patent infringement case that we took all the way through -- well it actually didn't quite to go to trial.

We won on pre-trial motions, summary judgment and infringement against Stinger Systems, a company that was violating several of our patents.

That company was effectively dissolved in the Florida State equivalency of bankruptcy proceedings.

We believe that's a very strong message that TASER will defend our intellectual property.

It is core to our business, it's core to our mission and we believe we have the capability to do so very effectively.

Finally, we took some important measures to streamline our cost structure in 2010.

Again, it was a bit of a tough year at the top line.

We saw 16% decline in revenue, but due to some of the rigorous steps that we took in streamlining our processes and our expense structure, by the end of the year, we were able to end the fourth quarter on break even on a GAAP basis, obviously, significantly with lower sales than the year before.

But perhaps more importantly, we were able to generate almost $3 million in cash from operations.

We believe that's positioned us as we move into 2011, and as we, obviously, work on bringing the top line back to and above historical levels that the business is really positioned to be able to leverage increases in sales to consistent cash earnings, and hopefully we'll see that leverage generate throughout a GAAP basis as well.

Before I move into talking about 2011, I'm going to hand it over to our CFO, Dan Behrendt, to give a little more detail about 2010.

Thanks, Rick.

Let's start with the results for the fourth quarter.

Revenues, as Rick said, for the fourth quarter were $22.9 million.

This is down approximately $8.2 million from the prior year adjusted revenues which were impacted by the $3.5 million referral related to the X26 trade-in program that we started with the introduction of the X3 electronic control device.

The decrease in sales versus the prior quarter was primarily driven by fewer individually significant orders, especially to our international customers, and the delays in getting the [AXON, EVIDENCE.COM] market as well as a reduction in stimulus funding for law enforcement equipment that we saw in 2010 versus the prior year, 2009 where we saw a much higher stimulus funding for our products.

Total year of sales for 2010 were $86.9 million.

This represents a 16% reduction from 2009.

The gross margins for the fourth quarter of $11.8 million are 51.7% of sales.

Our GAAP 7.2% of percentage ofsales.

This was really one of the bigger impacts and drivers for that reduction is the fact that we're now including $1.1 million of software to service data center costs, and software maintenance costs in to the cost of goods sold line.

This represents about 4.8% of sales, so that's a big part of that reduction because we are now including those costs up in the costs of goods sold.

The remaining 2.5% decline is really driven mostly by decreased leverage on our fixed manufacturing overhead costs with the lower sales levels this year.

We are seeing improvements in our direct manufacturing costs, specifically in labor.

The automation is really starting to have a positive impact on our margins, and seeing the efficiencies related to some of the greenbelt projects we started during 2010.

Moving on to SG&A expenses.

SG&A expenses for the quarter are $9.3 million.

This is down $0.5 million from the $9.8 million in the prior year.

SG&A as a percentage of sales were about 40.8% of sales compared to 31.5% of sales in the prior year.

Again, it is all driven by leverage because we are seeing reduction in the net SG&A costs due to some of the cost restructurings we have taken during the year.

Most of the reductions form the prior year are driven by lower salaries, benefits and stock compensation.

The growth research and development expenses for fourth quarter were $2.5 million.

This is actually down $3.1 million, compared to 2009.

Decrease is driven by the fact that the EVIDENCE.COM data center costs are now up in costs of goods sold of $1.1 million, but also just structural changes where we reduced the overall spend in research and development as some of the products that we started previously are through most of the development, and we have seen a reduction in expenses.

We'll continue to focus on the cost controls, and making sure that expenses are managed as we gear towards returning to both near-term and long-term benefit for the Company and getting leverage out of the fixed cost of the Company.

On a cash basis with the ramp up of our software development team in California, and the resulting increase in 123R stock compensation, and also the depreciation caused by the higher capital expenditures over the past couple years, especially the automation equipment put in place, we believe it makes sense to look at operating income on both a GAAP basis as well as a traditional, on a cash adjusted basis.

The noncash P-Notes expenses have grown to the point where it makes sense to break them out.

So on a GAAP basis, we actually had a pre-tax loss of $31,000, and a net of tax loss of $197,000 or $0.00 loss per share both basic and diluted, but on a cash basis, we did see income for the quarter of $2.9 million.

For the full year we saw revenues of $86.7 million.

This is down $17 million from the prior year.

Again, we talked about the impacts of the economic downturn on municipal spending, the reduction in stimulus funding, all of those things had similar impact on the total year sales.

Gross margins for the year were $45.4 million, or 52.2% of sales.

Again, the impact of the EVIDENCE.COM data center costs are impacting gross margins about $3.2 million for the year or 3.6% of sales.

We're also seeing lower leverage on the fixed cost, but, again, if we're successful in growing the top line, we'll see that leverage return to the indirect manufacturing costs improving our gross margins.

SG&A expenses of $39.1 million havedecreased $4.4 million.

Again, contributed to the cost-control measures we undertook during the year which saw reductions in payroll costs versus the prior year of $1.2 million.

Reduced consulting costs by $1 million.

Reduced professional fees by roughly $850,000 and travel down $350,000.

So we're seeing dramatic impact to those costs restructurings that we have taken during the year, and we're seeing that play off of the SG&A line and R&D.

Our gross R&D expenses for the year are $12.7 million.

That's down $9.7 million on a gross basis versus the prior year.

Driven by a $5 million reduction in indirect supply, tooling and scrap charges.

Again, we had much higher expenses in those areas last year, due to the project development costs for AXON and the X3.

We saw a $2.3 million reduction in salaries and benefits following the headcount reductions, and $1.2 million reduction in consulting expenses as volume development effort of EVIDENCE.COM has scaled down.

The gross 2010 and 2009 R&D expenses are offset by $1.3 million and $2.3 million respectively of capitalized salaries and consulting fees for the development of EVIDENCE.COM.

2010 adjusted operating income of $5.8 million is the result of adding back the 123R charges and the depreciation and amortization charges of $11 million.

This compares to $8.5 million in the adjusted operating income for the prior year.

We had a GAAP operating loss for the year of $5.1 million compared to $79,000 in 2009, and the net loss for the year is $4.4 million or $0.07 a share on both a basic and diluted basis.

Moving on to the balance sheet.

We did finish the quarter, as Rick mentioned, with $42.7 million in cash and investments.

We actually had about $2.5 million increase to cash in the fourth quarter, mostly driven by the cash earnings.

Overall our cash is down $2.8 million for the prior year, but considering the sales levels for the year, and the investments we have made in the business, I think that's a good result for the year.

Accounts receivable of $13.5 million is down $1.8 million for the prior year.

Mostly due to the timing collections and lower poorly sales in the fourth quarter of 2010 versus the prior year.

Inventory finished the year at $17.8 million, this is up $2.7 million for the prior year.

Again, that's really driven by the inventories for the AXON on-officer video devices is the biggest driver there.

Prepaid and other assets of $2.9 million are up $1.3 million mostly driven by income tax receivables and other long-term assets.

The investment in property and equipment of $35.9 million is down $2.8 million.

This is really driven by the fact that we have got $7 million of depreciation expenses now.

We have offset that with some new investments, $1.9 million per production equipment and computer equipment for this year, and another $2.2 million of capitalized EVIDENCE.COM protector platform development costs.

And we finished the year with total assets of $136.1 million.

On the liability side of the balance sheet, accounts payable of $4.6 million is down $1.8 million from the prior year really driven by the timing of differences in AP check runs, as well as, we had year-end 2009 we had the final payments for the automated cartridge line still at payables at year end.

Those are paid in the first quarter of 2010.

Current liabilities was $3.8 million, decreased $0.5 million due to decreased use tax, decreased bonuses due to lower sales and then decreased legal accruals.

The total deferred revenue of $7.7 million is up slightly, $67,000 from 2009 related to the trading credits, and the extended warranty sales.

Full liability is $18.6 million and finished the quarter and the year with $117.6 million of stock-holder's equity.

We've gotno long-term debt and to have to liquidity to fund R&D and operations as we move in to 2011 here.

On the cash flow, the Company did have cash from operations for the year of $784,000, compared to $10.1 million in the prior year.

The per year cash and operations is driven by a number of factors including the cash operating income of $5.8 million.

We did have another offset by $1.8 million receivables, $2.1 million in non-cash charges for inventory and warranty reserves, and those are offset by $4 million increased inventory, a $1.7 million increase of prepaid and other assets, and a reduction of AP of $3.3 million.

Again, significant cash generated from operations.

The prior year was driven by the cash earnings of $8.5 million, and various changes to the operating assets and liabilities with the most significant being an increase in inventory of the prior year of $2.4 million.

Net cash used by investment activities in 2010 was $4.5 million compared $11.7 million in the prior year.

Again, the decrease was driven by the decline of production in computer equipment purchased this year versus last year.

Last year we saw the purchase of the automation equipment as well as a significant amount of capitalized cost relating to EVIDENCE.COM development.

We did finish the year with $42.7 million in cash.

And we're confident that our strong liquidity will provide us with the means to manage the business during these challenging times while also allowing us to focus on growing our business throughout 2011.

We might as well run through the sales statistics before turning it back over to Rick Smith.

The X26 units for the fourth quarter were 10,222.

We sold 3,792 M26 units.

We sold 1,106 X3 units.

We sold 3,909 C2 units, 1,535 TASER CAMs, and cartridges sales for the fourth quarter were 319,459 and with that I'll turn it back over to Rick Smith, our CEO.

Thanks, Dan.

All right.

I want to talk about 2011 now.

In particular, I want to focus on the Company's top priorities, so we'll talk about our five key priorities for 2011.

Our first priority is efficiency and profitability in the business.

As I mentioned before the break, I am pretty proud of the efforts that we have taken to streamline our cost structure in the declining revenue environment this past year, able to generate $3 million in cash on lower sales in the last quarter.

We believe that's a trend that we can continue well in to 2011 from a cash-generation standpoint.

We are coming off of a large investment cycle.

You'll recall in late 2007 and into 2008, we talked about the opportunity we saw with the emergence of video and the data storage and management challenges that video presents to professional agencies like law enforcement.

We see that as an important opportunity, an important trend, and we decided to fundamentally invest the profits of the business over the ensuing few years into building a software to service and hardware capability that would enable us and position us to where the market was going.

We are skating to where we see the pocket a few years ahead.

In intervening years, we did have a global financial crisis, but as I think I mentioned before, we believe that we have taken the right steps to position ourselves very well as we come out of this cycle both from an investment stand point of TASER and from the global economic cycle perspective.

I am also pretty proud that if you look at it we have been fundamentally able to fund this new business opportunity out of cash from operations, and maintain a strong balance sheet with fundamentally no debt as well as starting to return now to a cash-generation type mode.

Another thing I think you'll see is our product development capabilities have really matured.

If you look at the, frankly, massive increase in R&D spending that occurred from 2006, 2007, 2008, and 2009 -- anytime you have that much capability to make a heavy investment cycle, it's a learning opportunity for the organization as well.

And frankly, you don't hit the ball right on 100% of your investments, but what you do is learn important organizational capabilities and now we have to take advantage of that and streamline it to where I believe what you'll see in 2011 and beyond is comparable or even greater levels of product [dividation] at significantly reduced spend levels.

So I have had some investors ask me about, with some concern, about the sequential decline in overall R&D spend, and my answer to them is we're not cutting back on the pace or capabilities that we're developing for our customers.

We're just really able to mature and streamline those operations as an organization, such that we're getting a lot more bang for our buck and I think we will see significant dividends from that..

We have also spent significant efforts on formalizing our voice of the customer integration.

Last year we held our first formal innovation summit where we brought together engineers from throughout our Company, our sales force and various representatives of our customer base to better understand our customer's need, and found it to be a highly engaging event, very instructive for our engineers to become much more tightly integrated with our customers.

We coupled that with a number of quantitative tools that we're using to gain wide-spread quantitative data about customer technology use, the challenges they are facing, their most pressing need.

So between a variety of qualitative and quantitative tools, we believe that we're really generating a product innovation and deployment machine here at TASER that is tightly coupled with the needs of our customers, and we're getting better and better at it and that bodes well, in my opinion, for the future.

We're also focused on finding new sources of revenue while we're streamlining our costs.

One example there is the wildlife phase that we announced this quarter.

We have certainly seen some humorous input on the wildlife TASER.

One of my favorite shows over at the Colbert Report did a fantastically funny segment on the wildlife TASER, But the product itself is really no joke.

We were able to develop the wildlife TASER for probably less than $20,000 in total.

It was some firmware changes and some testing required.

Not a huge lift, but it was something that many of our customers were asking for in that law enforcement across North America, really around the world, have in many cases animal-control segments that have to deal with wild animals in some cases.

Particularly in areas like Alaska, there are towns where a significant safety issue is bears that come into the town for feeding purposes, and those wildlife specialists are charged with trying to find ways to keep the bears out populated areas.

They destroy a lot of animals every year, and frankly, people get killed and injured as well.

And it's been related back to us that the wildlife TASER technology that was developed is uniquely capable of not only of incapacitating a wild animal so it can be tranquilized and moved, but perhaps more importantly, or more practically, animals that have been hit with the wildlife TASER, there's the important psychological effect where those animals do not return to the scene where the TASER was used.

And that is the fundamental goal of these wildlife control specialists to keep large predators out human populated areas.

Is it a huge market?

No, but we have had significant interest from around the world.

From African countries where they have some very large animals that represent certain challenges in dealing with the interactions of populations to those animals.

Fits with our distribution channels into these government agencies and it's a nice opportunity that with a relatively small spend, we believe the ROI will be very healthy on that project.

And I have been frankly, quite surprised at the level of real interest it has gained in wildlife control markets.

We're focused on careful market testing and growth.

At this point, the Protector product that we invested in last year, we introduced that at CES, we are selling it now in what I've characterized as a test market mode.

We have tremendous publicity and interest from that product.

At this point, we are looking very carefully at our go-to-market strategy.

We're not going to make heavy investments to try to build a consumer distribution channel.

As you all know that can be a very expensive proposition.

But we're focused on tweaking features and interacting with customers, and we're not going to invest heavily until we have a proven model.

At this point the distraction management market is one of significance importance at the highest levels of government, but it is a fairly immature market from the perspective of there's not a significant revenue base out in that marketplace on a competitive basis or for our product yet.

So we're going to take that carefully and manage it in line with the rigorous principals of making sure that we are focused on profitability and operational excellence this year.

Our second primary focus is the AXON and EVIDENCE.COM sales ramp.

AXON, one of our accomplishments in 2010 is that product is now commercially available.

We have a number of test agencies that began in late 2009.

Some agencies that purchased in early 2010.

Earnest sales efforts really began in the third quarter.

We are finding that the sales cycle is longer than we initially anticipated.

It is a more complex solution sale than our typical hardware sale.

And there's some maturation that is occurring in our sales processes and pipeline management.

Over the last year, we have put in much more rigorous sales management tools.

At this point, we're refining some of the features in partnerships with our customers.

This is a fairly complex end-to-end system.

And frankly at this point, one of the biggest issues we are working through are ergonomic issues and we have several new mounting systems coming on line this quarter.

When you are asking somebody to wear something on their head, comfort becomes a very primary concern, and we continually rearrange.

Really what we are finding is the more options we have available, every individual is different.

Some people want to wear it on hat mounts, some will wear it on a head band, some will wear it on glasses, some want to wear it mounted on a collar or somewhere else on the upper torso.

But we are iterating through those.

The important point is just the valued proposition that we've put forth is very well received, and we're seeing near universal acceptance that these types of systems are coming.

It is rare, in fact I cannot recall, a customer that we have met with that has disputed that this is the future.

They all recognize that video systems are coming, that they believe they will be standard issue equipment for every officer in the future.

Obviously, there are some different view points as to how long that process will take.

We're seeing consistent confirmation that we are on the right path and we are in a growth space.

Let me give you one example from a quote from one of our customers, and this will give you an idea of why I'm so enthusiastic about the AXON and EVIDENCE.COM business segment.

Quote, "We have been using AXON system for several months now and are extremely pleased with it.

First of all it bolsters our case preparation with strong audio and visual evidence.

It will lower costs by reducing court time,records and evidence staff time, IT staff time, and city and county attorney prep time.

"It has also reduced the number of false allegations against our officers.

When complaints are initiated we invite the complainants to come in and view the AXON video with us.

So far no one has taken us up on that invitation, but after discussing with our current policy and procedures concerning internal investigations, our city attorney told us that if video captures the event, that the video can stand as the formal investigation.

Under those circumstances, it avoids the entire need for statement of allegation, [garity], officer-witness interviews, et cetera.

"We have been able to do that twice already.

One was an excessive use of force complaint.

The other was an improper stop and search of a vehicle.

Both times the videos clearly showed the officers did everything right.

The AXONs have been a great tool for us, and by the way, TASER has been a tremendous business partner to work with."End quote.

We've also this past year had the opportunity to build not only our internal staff, but our network of advisors.

You all saw that Hadi Partovi joined our Board as our newest Board member.

Hadi was the founder of Tellme Networks that was purchased by Microsoft a few years ago for a little under $800 million.

He was also a founder together with his brother of Internet Link Exchange, in the mid-1990s, also a very successful venture, and he is one of the earliest advisors to Facebook and he is very well connected throughout the tech community.

His last venture iLike was purchased by Myspace a few years ago.

We've also have established advisory relationships with a number of other folks in the software-to-service space, and we're getting a very positive feedback from those advisors that indeed there is some patience required when selling software as a service business, and particularly one that couples with a hardware solution that the sales cycle tends to be long, but these things tend to have a hockey-stick-like adoption for once you break through a certain level of performance.

And again, based on the feedback we're getting about the capability, we still have work to do in terms of we're finding exact features down, but our core value propositions are very well received and the core infrastructure is stable, enterprise-grade platform that is positioned for growth.

So at the end of the day, this has been a not insubstantial investment both in terms of time, and focus, and personnel and financial resources.

However, it clearly has the potential to be comparable to, or frankly, significantly larger than our core business.

So we continue to believe that in the signs for the market are that we believe this will have been, as we look back on it in a few years, an excellent opportunity for the business to have moved into.

That leverages our core business relationships in law enforcement, our core training capabilities, our hardware innovation, and our now software development capabilities we have built for the last few years.

So AXON and EVIDENCE.COM., lot of promising things happening there.

Our third area of focus, in the international space.

International orders, again, I believe we're over 20% of revenue in 2010.

We have recently announced a number of additional orders in the international space.

We continue to see a very robust pipeline with significant opportunities ahead of us in 2011.

Our fourth area of focus is really developing a world class people-advancement system.

Our human-capital systems have become much more rigorous in the past year.

Anybody who went through TASER's interviewing and recruiting process a few years ago found it was very informal.

It has become very rigorous.

In fact, again, Hadi Partovi, one of our advisors, has been recently charged with helping Facebook to establish their Washington State presence, and one of his real areas of expertise is in human-capital systems, and frankly, Facebook and Google are considered best in class.

I am proud to report actually that just in the last few months one of our latest recruits, a Stanford mechanical engineer who had gone through recruiting at Google, we did the interviews with him.

Post our interviews process related back to us that he found the TASER interviewing selection process every bit of rigorous as Google.

Something that we take tremendous pride in hearing that back.

So we're recruiting throughout the organization, particularly at the engineering and entry-point levels in the Company.

Planting the seeds for the trees that will grow into -- really help this Company have the right systems and people to grow over the long-term, as well as we have been spending a lot of time in the last six months on our internal review feedback and people-development processes.

Because obviously the people of any business are the core, so we're really putting the right systems in place to grow and develop our people, and to continue to recruit best in class.

Those are things that we believe will lead to long-term leverage in the business, as we continue to improve the rigor of our execution.

And finally the fifth major focus for this year is driving an upgrade cycle in our core ECD business.

We saw we ended the year with the order from the Arizona State Patrol, upgrading from their X26s to X3s.

Last year we did announce the end of life of M26 in North America.

We did see that did help many agencies to upgrade their systems to the X26s.

We do have a significant portion of our installed base with weapons that were bought in 2003, 2004, 2005.

They are recognizing that those devices are now over five year's old, and one of the analogies we use is nobody is carrying the cell phone they had five years ago.

Electronics do have finite lives, and we're very much focused on working with our customer base to bring them the right solution, and opportunities to upgrade that hardware, and we believe that has the opportunity to be significant in 2011 and beyond.

So at a very high level, our focus is on returning to profitability in 2011, by finding new sources of revenue.

Both [iterably] like the wildlife TASER with relatively low levels of investment, repurposing some of our technology to adjacent market, finding relatively low lift ways to create value to take advantage of our distribution chain and our existing market, and doing this in a rigorous way that is very much focused on efficient execution with good cost controls so that we can grow the top line and get the leverage in at the bottom line that we believe will make this is a very exciting business on a financial basis, the same way it that it's exciting, I think, today on a promise in innovation basis for the products that are coming out of our pipeline.

And with that, we'll take a few moments to take some questions, and then we'll send everybody on their day.

(Operator Instructions).

Gentlemen, your first question comes from the line of Eric Wold with Merriman Capital.

Hi.

Good morning.

Morning.

Morning, so question on the replacement cycle that we're waiting for and could get a start again in the second half of this year when budgets open up.

Do you think you would need to do any discounting or trade-in promotions to get that going or are you hearing any feedback from agencies on that?

And would that be advantageous to keep those used devices off the street and get them back in to your hands to eliminate that issue?

Yes, Eric this is Dan Behrendt.

That's a good question.

I think what we saw in 2010 is that we did have to give in some cases some small trade-in credit.

It's probably more of an emotional issue to give the customers some value for a product that is still fielded.

It was not that significant.

I think it just helped to drive things forward.

I think we're seeing more and more customers just acknowledge the fact that these products are at the end of their useful lives, and I think the fact that we have got a product that has got such a high ROI for our customers helps because in cases like in Houston, where the Chief went to City Council, they used the fact that this is a product that's had a high ROI as part of the justification to start upgrading their products over the next couple of years.

We feel very good about that process as we go forward, and the potential that affords the business.

This is Rick.

Let me comment on that as well.

I think your point about having some trade-in credits to get some of the older devices out of circulation there's merit to that as well.

But in terms of a driving factor, we believe the bigger factor in 2011 will simply be, frankly, the fact that the boogie man of pending staff cuts is getting behind many of our agency customers on a time basis which allows them to then start to focus more on, "Okay, we have been through the adjustments now, what do we need to do" -- a lot of the capital equipments just really, in need of upgrade including their TASER devices.

That's sort of the key, and then we have [a host of] different types of trade-in programs over time, and that will likely remain part of our strategy to help drive that process.

Follow-up on that.

Are you likely to see the X26 user that are getting toward the end of life on the device stick with the X26 and replace that?

Or are you getting feedback that they are actually considering a greater potential of moving up to the X3?

We're seeing both.

And we're focused on from a pipeline perspective, making sure that we have got a suite of product that's compelling in terms of upgrades.

Obviously, we would like to bring our customers up to greater capabilities, rather than simply replacing what they have as it wears out and comes to the end of it's useful life with the same platforms.

But we're seeing interest in both spaces.

Okay.

And lastly, looking at the international markets, and not looking for comments on specific countries or agencies, but maybe give a sense of where you are now versus maybe a year ago in terms of various trials going on with some of these countries that maybe be close to a decision.

What does the outlook look now versus maybe a year ago?

How close are a lot of these places?

This is Dan Behrendt, I think really the focus has been really in making sure that pipeline is as robust as possible.

So whereas a year ago, we were talking internally, externally about maybe just a few opportunities, I think that number has certainly increased over the year, and really focusing on leveraging our distribution network, and making sure that we have got a lot more things in the pipeline at any given time.

I do feel that from a pipeline perspective, the pipeline is certainly both a number of opportunities and the relative size is certainly better versus the prior year.

I would say as well we made some investments over the past few years in putting some sales offices abroad.

We have been experimenting with trying different types of approaches in different countries.

One example was actually putting a full-time trainer into a country, in order to help bolster the success rate of their deployment of the product and the end-user experience.

We have put more of a sales-oriented employee into another market.

We've used consultants in various markets in contrast to the typical route of using exclusive distributors.

So seeing more of a government liaison-type resources as opposed to product resellers, and I think that is part of the reason we're seeing a more robust pipeline.

We do tend to see the international market have a multiyear development cycle, so from the time you make those investments until you see the return is, what would you say Dan, probably 24 months or so?

Certainly 18 to 24 months which is part of why we want to have that big pipeline

So we're feeling pretty good about the international opportunity in 2011.

Final question.

If I look at the break down you gave, Dan, in terms of the units of each of your various product you used recent [ASPs] for that.

I am still getting short to the $22.9 million [footing] to that.

Was there any other large revenue in the quarter?

How large was the revenue from the other recent products like XREP and Shockwave, et cetera?

I think probably the bulk of the difference, Eric, is going to be driven by extended warranties, training, things like that.

That's actually got to the point where that is a fairly material part of the business.

So in any given quarter there is $1.5 million to $2 million worth of warranty and training.

And out-of-warranty-replacement sells in any given quarter.

Perfect.

Thank you, guys.

Thank you.

Your next question comes from the line of Greg McKinley with Dougherty & Company.

Thank you.

Can you give us a little more sense around what you anticipate the run rate to be in a couple of your operating expense lines?

I know we did see a big reduction in R&D for the full year, but it bumped up sequentially despite the reclassification of certain of those EVIDENCE.COM expenses from R&D to cost to sales.

I am wondering if you could talk a little bit about what caused the increase there despite that reclass and what we should expect going forward?

And then maybe also if you could just provide similar color on General and Administrative expenses?

Then finally, on your gross margin rate.

Again, I thought perhaps with that reclass the margin rate may have been a little lower sequentially, but it was up sequentially.

Any observations you could share on that?

Good question.

This is Dan Behrendt.

So on the R&D side.

Probably the biggest difference from Q3 to Q4 is we had more of the software rework type expenses get reclassed up into cost of sales.

In Q3 versus Q4 the majority of our software development efforts were really on new features than traditional development.

So that amount of the reclass up to cost of good sold was significantly lower.

On a total spend basis it's really a pocket chip between R&D and gross margin.

The expenses we saw for Q4 it's going to be around that range as we go into 2011.

Potentially a little bit higher, but on a run rate basis it's not going to be dramatically different than that.

As far as SG&A kind of the same thing.

Obviously, there is fluctuations in SG&A quarter-to-quarter (inaudible), depending on activities, trade shows.

Second quarter we all see higher SG&A because of the cost related to creating an annual and mailing annual reports and doing the shareholders meeting and stuff, but overall we are really focused on keeping the cost down in 2011 to make sure we are getting leverage back in the model.

On a gross margin side.

Leverage -- we are going to continue to work it to get more efficient on the operation side of the business.

We have done a lot of quality training and greenbelt trainings.

We've got a number of those projects we think will bear fruits in 2011.

But there is still -- especially with the automation and some of the other investments there is a fair amount of fixed cost, so really leverage is going to be a big driver to the [impairments] of margins as well as we go into the current year.

We do feel that we are really well positioned.

If we could start getting some traction and start seeing some sales increases I think we are well positioned for profitable growth there.

Thank you.

Sure.

Go ahead.

No, I was just going to turn the call over to you.

Go ahead.

Okay.

All right.

Well again, I like to thank everybody for spending your time with us this morning.

Have a fantastic day.

We will be back to talk to you in, I believe, April.

Here's to a fantastic 2011.

Thank you very much and have a great day.

Ladies and gentlemen, thank you so much for your participation in today's teleconference.

This concludes the presentation and you may now disconnect.

Have a wonderful day.